UNITED STATES BANKRUPTCY COURT

EASTERN DISTRICT OF KENTUCKY

COVINGTON DIVISION

IN RE:

STEPHEN MICHAEL HASTINGS

LISA KAREN HASTINGS

DEBTORS                                                                                        CASE NO. 05-24546

MICHAEL L. BAKER, TRUSTEE                                                                PLAINTIFF

VS.                                                                                                    ADV. NO. 06-2059

THE CIT GROUP/CONSUMER FINANCE INC.;

UNITED STATES OF AMERICA, INTERNAL

REVENUE SERVICE; MIKE HASTINGS and

SYLVIA HASTINGS                                                                                     DEFENDANTS

           This matter is before the court on cross-Motions for Summary Judgment by Defendant The CIT Group/Consumer Finance, Inc. (“CIT”) and the Plaintiff Trustee. This is another in a line of cases in which the Trustee challenges the validity of a mortgage based on an allegedly defective acknowledgment. The issues before the court are whether the mortgage was properly acknowledged, and, even if it was not, whether KRS 382.270 may be retroactively applied to defeat the Trustee. The third issue, raised in the Trustee’s Motion for Summary Judgment, is whether the interest of the Internal Revenue Service (“IRS”) in the subject property is subordinate to that of the Trustee. This court has jurisdiction of this matter pursuant to Judicial Code section 1334(b); it is a core proceeding pursuant to Judicial Code section 157(b)(2)(K).

           1.        Factual and procedural background

           On February 11, 2002, the Debtors executed and delivered a promissory note in the principal amount of $68,000 and a mortgage on real property located in Pendleton County, Kentucky (“the Mortgage”). The Mortgage was lodged for record on February 21, 2002, and recorded in the Pendleton County Clerk’s office. The notary’s certificate of acknowledgment reveals that the Mortgage was acknowledged in Hamilton County, Ohio; the certificate does not identify the Debtors as the mortgagors.

           On October 12, 2005, the IRS recorded a Notice of Federal Tax Lien in regard to Debtor Stephen Michael Hastings. The amount of indebtedness asserted against him is $59,382.95. The Debtors filed their Chapter 7 case in this court on October 14, 2005. The Trustee commenced this proceeding by filing his Complaint on March 17, 2006, seeking to avoid the Mortgage and liquidate the property for the benefit of the estate. Both Motions for Summary Judgment were filed on August 2, 2006, and the matter was heard on August 30, 2006 and taken under submission. An Order of Submission was entered on August 31, 2006.

           2.        Discussion

                       a.        The Summary Judgment Standard

           at that moment. While it is state law which determines whether the Trustee may be a BFP, it is federal law which fixes his rights as a BFP as of a date certain, in this case well before amended KRS 382.270 came into existence. As discussed by the court in In re McKeag, 104 B.R. 160 (Bankr. D. Minn. 1989), the Supremacy Clause of the United States Constitution makes federal law “the supreme Law of the Land.” U.S. Const. art. vi, cl. 2. The court there was considering whether the Minnesota legislature’s enactment of a statutory amendment with professed retroactive effect could be applied to allow the addition of a limitation on the amount a debtor could claim as exempt under state law. Bankruptcy Code section 522(b)(2)(A) provides that a debtor may exempt only property exempt under state law that is applicable on the date of filing of his petition.

           In that case, the debtor had filed his petition before the subject amendment took effect. The court stated:

[S]tate statutes which conflict with federal statutes are subordinate and unenforceable. . . . A state statute is in conflict with a federal statute if the challenged statute stands as an obstacle to the accomplishment and execution of the full purpose and objectives of Congress. . . . If the statute frustrates or interferes with the full effectiveness of federal law, it is preempted and unenforceable.

The filing of a bankruptcy petition creates an estate at the time of filing which is comprised of all the debtor’s legal and equitable interests in property at the time and, to a limited degree spelled out in the Code, to certain interests acquired after filing. As of that date, the trustee in the case obtains certain avoidance powers, preference and fraudulent transfer time tables are established, and postpetition transfers are restricted. As of that date, with some limited exceptions, the rights and remedies of the creditors of the debtor are set, with neither group generally having the right to improve its position. It is the date of filing which sets in stone the legal relations between the debtor and his creditors.

Id. at 164-65 (internal quotations and citations omitted). The court found that retroactive application of the amended statute would alter the parties’ rights under the state exemption scheme and held the statute to be unenforceable as being in conflict with a federal law which has superior status. Id.       This court agrees with the McKeag court’s reasoning, and concludes that retroactive application of amended KRS 382.270 would impair the Trustee’s vested rights as a BFP. Amended KRS 382.270 is in conflict with a federal law and therefore unenforceable, and the Trustee may avoid CIT’s lien.

           d.        Treatment of the IRS’s lien

           The Trustee has asserted in his Complaint that any amounts that would otherwise be secured by the IRS’s lien should be paid to the estate, and the lien treated as an unsecured priority claim pursuant to Bankruptcy Code section 724(b). In his Motion for Summary Judgment the Trustee states that CIT’s lien would have been superior to the IRS’s tax lien under state law, as the IRS recorded its lien on October 12, 2005, more than three years after CIT recorded its mortgage. CIT’s avoided lien is automatically preserved for the benefit of the estate pursuant to Code section 551, and, the Trustee contends, the estate enjoys priority over the IRS’s lien up to the amount of CIT’s mortgage as provided in Code section 724(b)(1).

           The IRS responds that if CIT’s lien was never perfected, it could not have been effective against subsequent lienholders such as the IRS and is not senior to the IRS’s tax lien. The IRS goes on to assert that there is no perfected lien to preserve for the benefit of the estate. The IRS also states that if the Trustee avoids CIT’s mortgage, the federal tax lien would be subordinated to priority claims pursuant to Code section 507(a)(1)-(7) as set out in Code section 724(b)(2), but that the IRS is entitled to payment pursuant to the provisions of section 724 whether the Trustee avoids the mortgage or not.

           Courts have consistently held that preservation of a lien avoided under Bankruptcy Code section 544 puts the estate in the shoes of the creditor whose lien is avoided; preservation does not improve the estate’s position viz-a-viz other creditors. A later, properly perfected creditor prevails in this instance, and the estate’s lien is junior to that later perfected security interest. See In re Carvell, 222 B.R. 178 (1st Cir. BAP 1998). The court must therefore agree with the IRS that its lien is superior to that of the estate, and that it is to be paid as a secured creditor from the proceeds of any sale of the subject property.

           An order in conformity with this opinion will be entered separately.

Copies to:

Debra S. Pleatman, Esq.

Adam R. Kegley, Esq.

Charles H. Keen, Esq.